Friday, July 27, 2012

Here's a quick update on some key measures of systemic risk in the Eurozone. Swap spreads in Europe have been declining all year, and although they remain somewhat elevated, they tell us that the ECB has managed to restore a good deal of liquidity to the banking system. Liquid markets are essential to an economic recovery. U.S. swap spreads remain very low, a testament to how much the U.S. economy has avoided Eurozone contagion.

The Eurozone has yet to solve its underlying problem (excessive spending), but as this chart of 2-yr sovereign yields shows, the risk of large and potentially disruptive defaults has receded significantly.

The ECB may start printing money, and in this case that is good. The Bank of Japan says it will tolerate a one percent inflation rate, up from zero, The Fed is stuck, but maybe its eyes are opening up.

We have seen (as Grannis' charts indicate) 20 years of declining interest rates, global, in major economies. The trend lines run to zero.

This secular and global trend cannot be explained by any USA politics or monetary actions. We live now in a global economy.

The Fed, and other central banks, cannot stimulate using conventional tools. We are at zoo bound, or close enough.

Structural impediments we have (and I would be gladly rid of), but less than the 1960s-70s. BTW the 1960s had robust growth and low inflation, and the top federal income tax rate was 90 percent. It is not structural impediments that tanked the global economy in 2008, but rather tight money.

Central banks, like all public institutions, do not respond to market forces and are not driven out of business by poor performance. They develop sanctimonious missions and exalted goals, quite apart from economic reality.

Just as the USA has a food stamp program in a nation of fatties, or a ethanol program when fossil fuels are booming, we also have a central bank ever blabbering about inflation.

I think a change that both the EU and US should consider are charter/constitutional amendments that outlaw public spending for all but essential services, with "essential services" being defined as "uniformed services" -- people who work for governments who do not wear uniforms should either be put into uniforms (lawyers & judges can wear robes; FBI agents can wear uniforms; government healthcare personnnel can be required to wear US Public Health Service uniforms; etc) -- politicians and anyone that is not required to wear a uniform would be required to work as volunteers -- a US constitutional amendment making public employment other than uniformed services in fact, unconstitutional, would be a major improvement and would require cancellation of the lard spending we call public employment -- the EU should do the same in its charter -- just an idea that needs to be further developed...